How to Cure What Ails Europe's Venture Capital Market

The Market Needs a Pan-European Effort to Attract Private Investors, Increase Diversification, and Support Europe's Entrepreneurs, Says a New Report from BCG and IESE Business School

MUNICH, GERMANY--(Marketwired - Oct 19, 2015) - How healthy is the European venture capital (VC) ecosystem? By some measures, it's thriving. VC investments are on a healthy upward trend, returns and money multiples are growing, innovation hubs are emerging, and serial entrepreneurs are flourishing. But European fund-raising has steadily slowed, while U.S. investment in European ventures is on a sharp upward trend, according to a new report from The Boston Consulting Group (BCG) and IESE Business School.

The report challenges the conventional wisdom about the European VC scene, which holds that:

Top VC performers' returns can't compete with those in other asset classes.

The investor mix is skewed far too heavily toward government entities, whose main objective is to build up regional or national champions rather than to earn financial returns.

The general partner landscape is opaque and highly fragmented, with many subscale VC funds.

"Such criticisms have some foundation in fact," said Michael Brigl, a BCG partner and coauthor of the report. "But a closer look at the European VC market reveals that, in fact, not only did returns on VC investments grow at a 7 percent compound annual rate from 2011 through 2014, but also that VC investments in Europe are at a secular peak. They surged strongly from 2012 through 2014, growing by 73 percent." Investment levels now stand at their highest point since the bursting of the dot-com bubble.

But since 2012, European fund-raising has plunged by 33 percent, while U.S. investment has increased by 45 percent to approach a ten-year high. Although each of the top ten European funds raised more than EUR 100 million in 2015, and three of them raised more than EUR 300 million, the gap between U.S. and European investment has widened by about EUR 21 billion.

The chief cause of the slide in fund-raising is the relative absence of private European money. European institutional investors constitute a smaller share of the population of limited partners in VC funds than do U.S. institutions. Pension funds, for example, make up 14 percent of all private VC limited partners in Europe, compared with 29 percent in the U.S.

Making the situation worse, private investors have slashed their VC investment in both relative and absolute terms since 2008. Government agencies have covered the shortfall, stepping in to ensure that European start-ups obtain at least minimal funding. As a result, the government share of investment in VC funds more than doubled from 2008 through 2014.

What is scaring off private European investors? For one thing, the current European financial-regulatory regime discourages equity investing. What's more, the European VC market is highly opaque, fragmented, and marked by a large number of small, nationally focused funds, making it difficult for institutional investors to write large investment tickets. As a result, many successful young companies lack the later-stage support they need.

Toward a More Investor-Friendly European VC Market

Several reforms are necessary to draw in private European capital to support the continent's entrepreneurs. Most important, investors must be confident that they can earn returns on equity of at least 20 percent. But such performance requires further development of the European VC ecosystem. The following few points are mission critical:

To attract institutional investors accustomed to writing tickets of EUR 50 million or more, the market has to feature investment opportunities with a pan-European focus.

There must be funds that are large enough -- potentially with capitalizations of EUR 350 million or more -- to invest in start-ups at all stages of development, especially the late and growth stages.

VC funds and managers need transatlantic expertise and networking to support the growth of ventures in the U.S.

Governments can act as catalysts, but they cannot lead private investors in new fund vehicles.

As a potential interim step, market players should consider setting up a fund-of-funds layer that could attract both private and public money. Such a structure could leverage public capital as catalyst to scale up quickly. Canada has implemented a successful version of this approach.

In Europe, five to ten sector-focused funds of funds would be sufficient to cover the most important high-growth sectors. VC funds focused on these sectors could be selected on the basis of their track records or future performance expectations, because of the management team's expertise and experience. Fund strategies should privilege and encourage cross-border investment.

The structure outlined above would be an interim arrangement that would endure until private investments have scaled up sufficiently to establish a robust European VC ecosystem supported mainly by private capital. At that point, Europe's VC market would be largely a private affair, and Europe's status as a healthy, well-funded hub of innovation would be assured.

To arrange an interview with one of the authors, please contact Jenelle Tortorella at +1 617 850 3927 or tortorella.jenelle@bcg.com.

About The Boston Consulting GroupThe Boston Consulting Group (BCG) is a global management consulting firm and the world's leading advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 82 offices in 46 countries. For more information, please visit bcg.com.

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